A proper grasp of financials can help you better understand your buyer. Remember a buyer is not only comparing your solution to possible competitors, but all other forms of investment. You're not the first solution they've bought either. The most important point to remember about financials is that you often need a combination of metrics to prove your value. Financials can speak to time, risk, and/or overall value. Try to understand which financial metrics are being used to manage your prospects business. If you are unable to identify the decision making process being used, take the time to use these financials as a way to educate your prospect on what an economic buyer should look for.
Return on Investment (ROI)
ROI is the number of times a project pays for itself. For example, a 500% ROI means the project pays for itself 5 times. Including a time constraint with ROI is important. A 500% ROI in 1 year is impressive, a 500% ROI over 10 years is not! If your opportunity term is set to three years, make sure to say the ROI of your solution is 500% over 3 years. Companies would go broke funding every positive ROI presented to them. Present an ROI that lowers risk by also presenting Payback Period and EVA.
Formula
ROI % = Waterfall Total / Solution Cost * 100
Payback Period
Payback Period is the length of time required to return the initial investment. A shorter payback period is better because the initial investment is at risk for less time. Payback period does not take into consideration the time value of money. For example, a $5000 investment at the beginning of year that returns $500/month ($6,000 annual benefit) would have a payback period of 10 months.
Formula
Payback Period (months) = Solution Investment / Annual Benefit *12
Assumption
Annual benefit is evenly distributed. This can lead to a margin of error in calculating the exact payback month.
Month | Cash Flow | Net Invested Cash |
0 | -$5000 | |
1 | +$500 | -$4500 |
2 | +$500 | -$4000 |
3 | +$500 | -$3500 |
4 | +$500 | -$3000 |
5 | +$500 | -$2500 |
6 | +$500 | -$2000 |
7 | +$500 | -$1500 |
8 | +$500 | -$1000 |
9 | +$500 | -$500 |
10 | +$500 | $0 |
11 | +$500 | +$500 |
Net Present Value (NPV)
NPV is a stream of cash brought back to today's dollars. It is important to distinguish that this calculation accounts for the time value of money. For example, a stream of expected benefit of $30,000 ($10,000 annually) over three years has a NPV of $24,869 in today's dollars using an interest rate of 10%.
Formula
Where:
(r) Interest Rate
(t) Number of Years
(Co) Initial investment
(Ct) Cash inflow during period (t)
Assumption
Interest rate (r) is set to 10%, or the operating margin, whichever is higher. This leads to a conservative estimate. The operating margin field is found on the opportunity page header. If this field is left blank 10% is used for (r)
Economic Value Added (EVA)
EVA is the dollar amount of benefit the solution will create, over the life of the project, after removing all costs, including the cost of capital. This calculation is even more conservative than the waterfall total because it includes the cost of capital used to purchase the solution. If the EVA amount is positive, the company has earned more after-tax operating income than the cost of the assets used to generate that income. Simply stated, the company has created wealth.
Formula
EVA = NOPAT – (WACC * Solution Investment)
(NOPAT) Net Operating Profits after tax
(WACC) Weighted Average Cost of Capital
Assumption
(NOPAT) = Waterfall Total * (1-tax rate). We have assumed (tax rate) = 0%. Add local tax rate for a more accurate EVA calculation.
*Effective January 1, 2018, the corporate tax rate in the United States of America is a flat 21 percent due to the passage of the "Tax Cuts and Jobs Act" on December 20, 2017.
(WACC) is set to 10%, or the operating margin, whichever is higher. This leads to a conservative estimate. The operating margin field is found on the opportunity page header. If this field is left blank 10% is used for (WACC)
Internal Rate of Return (IRR)
IRR is the projected financial return expressed as an interest rate. Like the interest rate a bank will pay for the use of your money, IRR is the interest rate your customer expects to make on their investment in your solution. Companies use IRR to evaluate similar and dissimilar uses of their available capital. For example, a firm might have a required rate of return (RRR) which is the amount of IRR required to consider the project. If you are being compared on an IRR basis, make sure they are comparing projects of similar length, or adjust your opportunity term to match. IRR is the discount rate that makes the NPV equal to or closest to zero.
Formula
Set NPV = 0 and solve for (r)
Where:
(r) Interest Rate
(t) Number of Years
(Co) Initial investment
(Ct) Cash inflow during period (t)
Assumption
The entire solution investment is taken out as the initial investment.
Monthly Cost of Indecision (MCOI)
MCOI is the value lost every month the prospect decides to not solve the problems your solution addresses. MCOI adds urgency and definition to a possibly unknown problem. It should be supported by the value drivers to give context to the metric. For example, did you know that using a business case to defend your asking price could add $50,000 monthly to your bottom line.
Formula
MCOI = Waterfall Total / Opportunity Term (years) * 12
Assumption
(NOPAT) is replaced by the waterfall total, which does not include tax. Remove the tax rate for a more accurate EVA calculation by multiplying by (1-tax rate)
(WACC) is set to 10%, or the operating margin, whichever is higher. This leads to a conservative estimate.
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